Just a few years earlier subprime mortgages were a seemingly great advantage to many property buyers; Buyers who were interested in taking advantage of the hot real estate market but who lacked qualification profiles required by conventional and FHA mortgages, and instead turned to non-traditional and exotic mortgages offered by subprime lenders in order to obtain loans. The underwriting guidelines for these loans were generally more lax than traditional mortgages ("No Income/No Asset verification") loans for example. This allowed even buyers with poor credit to obtain a loan. In exchange for making a loan to buyer with less than stellar credit, lenders were able to charge a higher rate of interest.
The money which funded these loans came from a variety of sources. Low interest rates made it possible in many instances for lenders to actually borrow money and then loan out those funds to home buyers and higher rates thereby realizing a higher yield (profit) for themselves. In other cases, the money was obtained from more complicated sources. As you may or may not be aware, it was not uncommon for governments to borrow money from central banks. The housing market was stable back then; In fact, the housing market was experiencing a high that had not been seen in quite some time. Beyond the fact that many home buyers were taking on massive amounts of debt there also existed another problem. Due to the health of the real estate market at the time, there were expectations - by some experts - regarding future growth that, in hindsight, now is proven to have been unrealistic.
The last two full years of the real estate boom occurred in 2005 and 2006. During that time period lenders did not hesitate in the least to lend money to borrowers regardless of their credit profile (unless the applicant was so bad in all areas of qualification it would have been impossible to justify a loan to him/her). These loans represented tremendous money-making opportunities for lenders. Problems really began to occur; however, when interest rates began to rise from their previous lows. Historically, rising interest rates always had a negative effect on the real estate market. When rates are low they help to produce demand; however, when they are high they ultimately cause prices to fall. Until mid-2006 home builders could not build new homes fast enough to meet the growing demand. During mid-year; however, the demand began to slow. It was also about this time that the rate of defaults on loans began to increase.
Before long many mortgage lenders began to find it difficult to obtain money from their previous sources of funding. As a result, would-be buyers discovered that loans were no longer as easy to obtain due to the fact that money was no longer as widely available. Additionally, investors suddenly became wary of taking on risk and underwriting guidelines grew stricter. Homeowners who had taken out loans with adjustable rates began to find it difficult to meet their mortgage payments as interest rates continued to rise and those mortgages adjusted to make payments higher. More stringent underwriting guidelines meant they were unable to refinance to fixed rate mortgages in many cases. As a result, defaults continued to rise; fueling the massive rash of foreclosures.